Ever wonder why so many people opt for "no doc" and "low-doc" home mortgages that do not require verification of income or assets? Traditionally reduced-documentation loans were used by small business owners and self-employed professionals with complicated corporate profiles, partnership interests and irregular income patters because of bonuses or commissions.
Documenting income and assets for them was a big hassle and they welcomed loan programs that allowed them to simply demonstrate that they had good credit histories and adequate real estate collateral -- even if they paid a slightly higher interest rate for the mortgage.
But a new research study suggests that today's low-doc borrowers -- who represent more than 16 percent of all new mortgage volume this year -- may have other objectives in mind. The study, sponsored by Inside Mortgage Finance, an industry trade publication, and conducted by market research firm Campbell Communications, found that more than one of every six low- or no-doc borrowers are hiding income from the IRS.
They may assure the loan officer that they got $150,000 a year in annual income and can afford a big mortgage on a big house. But they only report $75,000 in income on their federal tax filings, and they don't want anything on the record that might alert the IRS.
The study, which polled a representative sample of 2,140 mortgage brokers active in the reduced-documentation field, also found that low-doc borrowers no longer are mainly self-employed professionals. Thirty-nine percent of all low-doc borrowers are salaried wage-earners who could easily produce a W-2 form if required. That's the identical percentage as self-employed borrowers.
When brokers were asked why their clients chose the low-doc route, more than 70 percent of them said a "significant" reason was that part of their income came from "a household member with poor credit." As an illustration, say Mr. and Mrs. Jones earn a combined $8,000 a month. Mr. Jones earns $6,000 of that, and Mrs. Jones earns $2,000. But Mr. Jones has a rocky credit history and very low FICO scores.
If their mortgage application identified Mr. Jones as he source of 75 percent of the income supporting the loan, the interest rate quote they'd get would be much higher. Instead, Mrs. Jones might simply "state" her household income as $8,000 a month, with no breakout on who earns what.
Nearly two-thirds of brokers said a significant number of their clients were "self-employed with unreported income," and 45 percent said their self-employed clients had "not filed tax returns."
Another 43 percent said a key reason for going the no-doc route was that borrowers "can't qualify under standard (debt-to-income) ratios used in the mortgage industry to underwrite loans.
One of every five brokers said "divorce or other legal circumstances" made low-docs attractive to clients. One of every seven said their borrowers had significant "immigration status" issues they didn't want on the public record. And finally, an eye-opening 8 percent said they knew their clients were actually "unemployed" -- so documenting their income was not feasible.
Tom Popik, principal of Geosegment Systems of Nashua, New Hampshire, who designed the study, said "it's pretty surprising how many (low-doc) borrowers are hiding income" from the IRS. The entire study, added Popik, shows that "there are significant risk factors" in many low-doc mortgages -- not simply for lenders and investors, but for the borrowers themselves and the realty professionals who assist them.
